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Fracking Woes Could Help China Blow Past Us

As we dither, China could take a fracking lead.

It seems like only yesterday that China was characterized by the Great Wall, hordes of bicycles, and nary a thought about starting companies to permit participation in global commerce. Little did we know that it would soon become the major market for the world's commodities, while essentially keeping the U.S. afloat with a stream of loans.

Now its adoption of the controversial hydraulic fracturing process, or fracking, just might allow it to further advance on us. Indeed, that's especially likely if our own fracking activities continue to face a steady flow of challenges.

Fracking involves a process wherein, once a well has been drilled to hydrocarbon-bearing rock (usually shale), the rock is blasted by a mixture of water, sand, and chemicals. Fractures in the rock then allow the trapped gas or liquids to make their exit.

Here comes ChinaThus far, China has only taken a few steps with regard to fracking. In its own country, PetroChina(NYSE: PTR) has reported some positive results in Sichuan province under the tutelage of Royal Dutch Shell(NYSE: RDS-B). And CNOOC(NYSE: CEO), the country's biggest offshore producer, is involved in U.S. fracking deals with Chesapeake Energy(NYSE: CHK)in the Eagle Ford and Niobrara shale plays.

But the country is gearing up to intensify activity on its own field, thereby allowing it to benefit from shale-gas reserves half again larger than our own. To help with the process, CNOOC and China Petrochemical Corp., or Sinopec(NYSE: SHI), are both in line with the likes of Saudi Arabian Oil Co. for a chance to bid for a 30% stake in Texas' sophisticated Frac Tech Holdings, which provides and operates the stimulation equipment and services that are vital to hydraulic fracturing.

The winning bidder will shell out at least $2 billion to join the ranks of current owners. Today, 70% of Frac Tech belongs to a consortium of investment and sovereign-wealth firms from Asia and Abu Dhabi, along with Chesapeake, which is a 30% holder. It's likely that the sale would be facilitated by the issuance of new shares by Frac Tech -- which is also considering joint ventures around the world -- along with sales of a portion of stakes by current holders.

There's no certainty about what sort of regulatory rules will face companies, foreign and state-owned, that ultimately participate in China's fracking expansion. But, with a seeming determination to reduce its choking urban pollution, I'm betting that those rules will lean in the direction of pragmatism and reality, and will generally be intended to enhance the amount of fracking in the country.

Damaged water?Meanwhile, our own fracking milieu is becoming a bit more shaky. There's long been concern about the chemicals used in fracking fluids and the potential that they could contaminate water tables near the drill sites. But 2011 also has witnessed intensifying concerns that the fracking process is guilty of spawning small earthquakes in the area of "injection wells," where the water is discarded once it's been used.

Concerns about fracking's effect on groundwater have been around for years, but were helped to spread virtually nationwide in 2010 with the release of a documentary film, Gasland, by a Pennsylvania filmmaker. Industry experts maintained that the film was fraught with errors and misinformation, but it nevertheless dealt fracking something of a blow.

More recently, that attention has been focused on Pavillion, Wyo., a town with a population of fewer than 200, whose groundwater the Environmental Protection Agency thinks may have been contaminated, primarily by the wells drilled near it. While the Wyoming wells are shallower, fracking typically takes place at depths exceeding 10,000 feet; most water tables are within 500 feet of the surface.

That, says Mark Miller, CEO of Cuadrilla Resources, is why "it would defy physics" for fracking chemicals to find their way into groundwater. (Earlier this year, Cuadrilla surprisingly made a major natural gas find through fracking operations near Blackpool, England.) Nevertheless, the peripatetic EPA forges on, and, as The Wall Street Journal noted in an editorial, "If the Wyoming study holds up under scrutiny, an industry that employs tens of thousands could be in peril."

Shake it up, babyPerhaps somewhat more plausible is the contention that pressure imbalances brought about by the discarding of used fracking water into injection wells can result in generally minor earthquakes. As my Foolish colleague Dan Dzombak noted recently, a series of 43 earthquakes that occurred in Oklahoma are thought to have resulted from fracking, a phenomenon that also occurred amid Cuadrilla's efforts in England.

In addition, Arkansas recorded 850 mostly minor events in 2010, up from 38 the prior year. Chesapeake was fracking actively in the state's Fayetteville Shale at the time. The company has since sold its Fayetteville assets to Australia's BHP Billiton(NYSE: BHP).

More than a few industry observers would echo the Journal's concerns about EPA overzealousness potentially leading to a moratorium on fracking in the U.S. As the newspaper also stated in its opinion piece, "The agency is dominated by the anticarbon true believers, and the Obama Administration has waged a campaign to raise the price and limit production of fossil fuels."

Batty excessive environmentalismBut it isn't only fossil fuels that are in environmentalists' scopes these days. Indeed, so-called green fuels attract their attention even before becoming economically viable. Among the concerns du jour is that bats are being killed by wind turbines, albeit without contact occurring. It seems that the bats' lungs essentially explode from the rapid pressure drop that occurs as air flows over the turbine blades.

Don't get me wrong: I'm not keen on damage to the planet. In fact, I consider myself to be an environmentalist and am most offended by real environmental destruction, such as is brought about by the equivalent of one Deepwater Horizon spill occurring through leakage in Russia every couple of months. But I am also concerned about those who would chase windmills and potentially curtail the operations of domestic natural gas producers, precisely as our Chinese friends are getting cranking.

From an investment perspective, all this is but one reason why my attention to oil-field-services kingpin Schlumberger(NYSE: SLB)continues to increase. Given the company's broad reach, poorly grounded domestic regulations will be at least partially offset by its international activities, including those in China. It's also a reason why the company belongs on all Foolish watchlists.